Can you solve - Corporate Finance Question

CFA Level II Corporate Finance
#1

Can some kind soul illustrate how they would calculate the amount of capital available for project investment - I’ve been stuck on this question for too long and any feedback would be greatly appreciated.

Projected NI = 14.25mill, Shares outstanding = 8mill, Div = $0.5 per share. Debt = 0.5, Equity = 0.5, what is the amount of capital available for project investment???

I used the Residual Dividend model

Dividend = Earnings - (captial budget * Equity in Capital Structure)

I did

0.5 = 1.78125 - (CAP BUD * 0.5)

Solved for CAP BUD, but that gets the wrong answer - can someone advise what I’m doing wrong? What answer to you get? Thanks in advance for taking time to read.

#2

I don’t understand what the quesiton is asking. After paying 4M in dividends (.5 x 8M), the company will have $10.25M in additional equity.

If they started the period with D/E of 1, aand they want to maintain that ratio, they need to spend it all. However if they borrow some additional cash, they may need to keep some of it ro kep the D/E stable.

That doesn’t really answer the question, but the question looks incomplete as stated.

#3

10.25 Million = NI available after paying dividends (Retained equity)

since debt / equity = 1 - they can borrow that much (10.25 mill) as well.

so they could have 10.25 Mill * 2 = 20.5 Mill for project investment???

#4

Yeah, cp, that’s probably what they are getting at.

#5

Thanks for feedback guys, CPK you’re right on the money.

Why is it that if I do same calc on a per share basis cannot get right answer…

CPK - not per share basis

-10.25 = -0.5Cap Budget… therefore Cap budget = 20.5 correct…

On Per Share Basis

-1.28125 = -0.5Cap Budget … Does not work

What am I missing??? Thanks

#6

You’re getting it on a per share basis.

Multiply 1.28/0.5 by 8mil.

#7

Thanks Mr Smart, I should have got that… Thanks again for your help…